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Stakeholder considerations in Corporate Voluntary Arrangements

22 Feb 2018

9 minute read

In a recent newsletter, we focused on a Corporate Voluntary Arrangement (CVA) of a hotel which successfully concluded with the subject company trading successfully. In this article we focus on how and why CVAs are not always advantageous.

CVAs have seen a chequered history since their introduction in 1986, the popular view being that they were a theoretical possibility for successful restructuring but would never be a popular and common rescue process. They have however returned to the headlines in recent months with cases involving High Street names such as Toys R Us, Byron Burgers and Jamie’s Italian. Problems arising for these companies are not unique and unlikely to be the end of the story for the High Street as most traders will be suffering the same pressure on margins and therefore profit and sustainability.

What is a CVA?

The aim of CVA’s is usually a device by which a distressed company can come to a negotiated arrangement where creditors agree a moratorium in respect of their debts and a payment schedule is agreed. Very often this is a ‘time to pay’ arrangement with all unsecured creditors agreeing to be paid from future profits or after disposal of assets. It often includes an element of ‘debt forgiveness’. In some instances, it is possible to negotiate particular terms with creditors (or class of creditor).To be accepted, 75% of unsecured creditors who vote on the proposal, must agree the terms. The key driver behind creditors approving a CVA is that they expect to get a better recovery under the CVA than in a liquidation or administration of the company.

The creditors may however ask themselves why they should agree to proposals if the company is to remain under the control of the same group of directors that led it into trouble. Accordingly, in proposing a CVA the Insolvency Practitioner acting in the process will want to demonstrate to the creditors what will change, how management will act differently in the future and why creditors should have confidence in the proposal being put forward.

The technical process v the real process

Technically the process is relatively simple – the directors draft a proposal, the Insolvency Practitioner checks it for accuracy and then copies of the proposal and the IPs report are sent to creditors, a meeting of creditors convened and a vote taken.

The reality is a lot more complex as CVAs are not just a process that involve unsecured creditors. Agreements will have to be reached with all key stakeholders to gather support for the proposed scheme whilst also keeping the company trading in the short term and achieving such understandings things can go wrong.

Reflecting on the three cases of Toys R Us, Byron and Jamie’s Italian, plus our own experiences here are a few comments on what each stakeholder is likely to consider before a CVA is agreed.

Landlords

In all three of the cases mentioned above, part of the plans involved the closure of loss making branches and rent reductions in some of those being kept open. Landlords being asked to take either a surrender of a lease or agree a rent reduction will have to be persuaded of the commercial benefit of them taking such a step

will they be able to re-let the premises?

what reverse premium might they receive for the surrender?

how long are they likely to have to pay business rates on empty premises?

what are the likely ongoing-costs of insurance and extra security?

how will an empty unit impact on overall general footfall and the fortunes of their other tenants in a shopping centre or on a High Street?

will any other tenants use the precedent to try to negotiate their own surrender of premises and thus start a domino effect?

Pension’s Regulator

In the example of Toys R Us, the proposal for a CVA was very nearly voted down by the Pension’s Regulator. Not only did the regulator consider the liability that might fall to be funded by the Pension Protection Fund (PPF) but:

if the company failed, would the proposal prevent employees, past and present to be paid out under the terms of the PPF?

what liability might there be if Toys R Us failed at some point down the line?

would the liability be higher if the company failed in the future, and how by how much?

how could the PPF protect itself against such an increase in exposure?

Terms were agreed, at the 11th hour, this enabled the CVA to be accepted with agreement to make substantial payments into the company’s pension scheme to protect the PPF against increased future exposure.

Employees

For employees, not only is their job at stake but also their ability to claim money from the Redundancy Payments Office accrues at the date of the first insolvency. Questions employees will ask themselves include:

how easy it will be to get another job now compared to if/when the company fails at some point in the future?

how much would they get now in the event of redundancy compared to how much in the future?

whether they actually have the will to help the distressed company?

We have dealt with at least one case where employees made it very clear that they wanted to be made redundant. Not only did the employees think they could easily find alternative employment but, the catalogue of excesses by the Directors over the recent history of the company resulted in them wanting the company to fail so that, in their eyes, the directors would be ‘punished’ for the unfair way in which the employees felt they had been treated.

HMRC

HMRC are in a unique position as not only are they creditors but they also have a public duty role with regard to the commercial community and to an extent are the guardians of corporate governance. Put bluntly, if they are too lenient with regard to non-payment of tax not only does the tax burden increase for all other tax payers but it could be interpreted as sending a message that non-payment is acceptable conduct. HMRC therefore have a number of key principles:

is the offer being made the best that can be made in the circumstances?

is the proposal capable of implementation in the manner outlined?

will the recovery for the tax authorities be better than can be achieved by any other insolvency process?

will future tax liabilities arising after the date of the arrangement be paid in the normal course of business?

are there any overriding reasons for rejection such as a history of tax evasion or a deliberate policy of non-payment of Crown debt?

Key customers

It may seem obvious, but it is often forgotten that without customers a business will fail and in the case of voluntary arrangements this itself has two aspects.

not only is it essential to demonstrate that existing customers will continue to trade with the distressed company once the arrangement is in place but,

it is also necessary to make sure that nothing will change in the future that might adversely impact on customers’ willingness to trade with the company in question.

In one case that we dealt with the company we were assisting was reliant on numerous Government related contracts most of which ran for between two and five years. We undertook due diligence to ensure that the insolvency clauses in the contracts would not be invoked and that relationships would continue. Trading continued successfully for about 18 months after the arrangement had been put in place but, as contracts came up for renewal, one by one they were not renewed and upon investigation it was discovered that under internal guidelines the Government agencies in question were not allowed to enter into new contracts with any company that had entered into a voluntary arrangement.

Key suppliers

Bankers

Finally, the bankers and associated providers of finance have a pivotal role.

will the overdraft and loans be called in?

will the factoring company continue to support?

will the lease hire, lease purchase or HP companies that have financed assets allow the agreements to continue or invoke their insolvency clauses

Understanding past behaviour

Whilst some stakeholders hands may be tied on how they react to a proposal for many the question of whether they will support a CVA is based on a number of factors of which the past behaviour of the directors is pivotal.

It is very simple but often ignored that creditors will ask themselves not only the commercial question:

what gets them the best recovery? But also;

whether they are inclined to help?

Answers will range from an immediate adverse reaction because a company has always been difficult to deal with to huge sympathy for people that they have dealt with for many years and with whom they have a good honest, trustworthy, relationship which they wish to protect.

The Insolvency and Advisory team at Shaw Gibbs have dealt with phone calls from angry creditors telling tales of the poor way in which they feel they have been treated by a particular company. Luckily, we have dealt with far more creditors who are willing to help because past relationships have been built on trust, honesty and good communications. It may seem trite to say it but whilst none of us expect or plan for financial distress in the future our conduct today may influence our chances of dealing with distress, if it ever happens, in the future.

Conclusion

This article has set out to show the difficulties of putting a good CVA together, some of the issues arising with stakeholders during the process and that acceptance of a scheme is not ‘job done’ but the start of a new life for the company concerned and rebuilding of not only its finances but it’s relationships and future prospects of success.
At Shaw Gibbs we have over 25 years’ experience of helping directors of distressed companies to enter into CVA’s including attending meetings with key stakeholders and advising on steps that can be taken to mitigate against adverse reactions.